The era of Micro-Financing

The year is 1976. Mohammad Younus, a young professor in economics at the Chittagong University in Bangladesh meets a 21-year-old woman, Sufia Begum, desperately trying to support herself. She has borrowed a sum of Rs. 10 from local moneylenders at an interest rate of almost 10 percent a day. She doesn't have much apart from the daily wage she makes selling bamboo stools, and as part of the terms of the loan, she ends up selling most of her work back to the moneylenders, making next to nothing. The young professor is moved when he sees this. He compares it to bonded labour and vows to end their suffering.

He finds 42 more people like Sufia, stuck in this poverty trap and starts lending them small amounts of money at reasonable interest rates. To his surprise, nobody in the group defaults. He decides to replicate his model throughout Bangladesh. Banks turn him down, Critics argue that providing loans without collateral is akin to throwing money away, but professor Younus perseveres. He creates his own institution and calls it Grameen Bank, Gram, meaning village and in 1983, this little institution is finally incorporated as a bank after the government passes legislation allowing it to accept deposits. The Grameen model would become widely successful and Professor Mohammad Younus would go on to win the Nobel peace prize for his work.

Credit Access Grameen Ltd.

The company that we have with us, Credit Access Grameen Limited is not the same Grameen Bank. Although, the company origin began with Seed Capital from Grameen Bank, it was later acquired by an NBFC and is now run by Credit Access Asia, an institution that hopes to make a profit while staying true to the Grameen model pioneered by Mohammad Younus.

The company predominantly focuses on women in rural areas. The ticket sizes ( size of loans) are small i.e. under Rs. 50,000 and these loans are mostly provided without collateral.

So, why do people repay their loans on time if they don't have to pay a penalty?

Well, there is a penalty and it's a pretty steep one. The loans are not given out directly to individuals, instead, the company asks women in a particular region to form small groups of 5-6 and when an amount is lent to an individual borrower, the whole group bears responsibility.

In the event that an individual borrower defaults on payment, the concept of social collateral comes into play, and the other group members repay the loan amount due. In case, nobody bears responsibility for the default, the group is blacklisted and deemed ineligible to receive further loans from any Micro Financing Institution (MFI). Social pressure is what gets people to pay.

But, how does the company grow if it continues to disburse such small loans?

The company operates in about 132 districts in 8 states. The ticket sizes might be small, but India presents a unique opportunity. According to CRISIL, India has the highest number of unbanked adults in the world, approximately 42 Crores. Currently, most of their revenue comes from two states, Karnataka and Maharashtra, and so the market is wide open for expansion.

The company has also introduced individual retail finance loans on a pilot basis for customers who had been with the company for at least three years. These loans were larger and were given out to individuals hoping to pursue their own business.

Here is a chart describing the growth in their loan book and active customer base

Is it profitable?

Yes. Although the original micro finance model was built for a social cause, Credit Access Grameen is operating as a for-profit entity and has become extremely profitable in the process, despite the fact that they mostly tend to rural areas.

According to CRISIL Research, the company had the lowest operating expense ratio amongst the top-eight NBFC-MFIs and one of the highest net interest margins. What this means is that the company has managed to keep it costs low in running its branches and has been able to extend loans at high interest rates (as high as 20%) and borrow at low rates ( as low as 11%). This helps in maintaining good profit margins and the numbers speaks for themselves.

But what if somebody else copies the model?

There are other micro financing institutions running on the same model. However, Credit Access Grameen Bank has built a niche for itself. It largely finances women who want to earn for themselves and it has stuck to mostly rural areas. The model is remarkably successful, so much so that the company boasts a retention rate of almost 90% while the industry average stood at about 78%. (Source:CRISIL Research, As on September 2017)

In addition, CRISIL notes that rural contribution to India's GDP is almost as large as urban contribution, but rural penetration of banks is far less than the urban penetration, and hence the competitive intensity in rural areas is far lower than that in urban areas.

Taking into account the opportunity and lower competitive intensity in rural segments, Credit Access has increased its footprint in India's rural areas unlike other industry players over the years.

So its an amazing company then?

Not so fast. You see, we began this story by talking about how the only reason people pay back their loans in this model is because there is peer pressure. But what if there isn't. What if there's a scenario where all the members in the group default because of an external event that is uncontrollable.

This happened during Demonetization. People started to default in large numbers and suddenly when everyone is doing it social pressure no longer exists. The company had very little non-performing assets (loans that are hard to recover) in 2016 and then after demonetization, these unrecoverable loans affected the profits significantly. It's still not panic mode, but it is something investors need to watch out for.

Point of Interest (Technical): Gross NPA Ratio was 0.08% as of March 31, 2017, which increased to 1.97% as of March 31, 2018. And Net NPA is 0.0% The provision for non-performing assets also increased significantly from Rs. 25.82 million as of March 31, 2017 to Rs 980.92 million as of March 31, 2018

Where's the money going ?

The company is planning to raise 630 Crores through a fresh issue so that it can take this money and start giving out more loans. The company's promoter, Credit Access Asia, an institution that holds 99% of the company also plans to sell some of their shares amounting to about 531 Crores (at the upper price band of Rs. 422) during the issue

Is it expensive?

Based on FY 18 earnings on post-issue equity basis, asking price is at a P/E of around 49. Although Credit Access does well on a few fronts, the asking price is still not cheap. Here is a table comparing its peers on a few technical metrics